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What If You Use Your Health Savings Debit Card For Take-Out?

Whoops! I printed out my year-end summary of distributions from my health savings account recently and saw a debit to a local take-out shop, Garelick & Herbs, for $12.62, obviously not an eligible medical expense. You’d figure you could simply return funds to the account if you make the mistake of pulling the wrong card out of your wallet, but nothing’s simple when it comes to the tax code, is it?

I checked the frequently asked questions from my HSA administrator, OptumHealthBank: “How do I report withdrawals that are used for non-eligible expenses? You must report distributions for ineligible expenses. Consult your tax advisor for specifics.” Hmmm.

Instead of emailing my CPA, I thought I’d try reading the Internal Revenue Service’s 7-page instructions to Form 8889 that you have to attach to your federal tax return if you have an HSA. Turns out you have to report distributions for non-medical expenses as taxable on your 1040 and pay a 20% penalty. More on that later.

Health savings accounts, which have only been around since 2004, come coupled with high deductible health plans. The number of Americans covered by these accounts has grown from 6.1 million in January 2008 to 13.5 million in January 2012, according to America’s Health Insurance Plans Center for Policy and Research.

Both you and your employer can contribute to your account on an annual basis—a combined total of $3,250 for an individual or $6,450 for a covered family (plus a $1,000 catch-up contribution for those 55 and older) for 2013. The money you contribute reduces your taxable salary, meaning thousands in tax savings for high-income folks. Like a 401(k) retirement account, the HSA is yours to keep. You can invest it, and it grows tax-free.

When you take money out for qualified medical expenses (defined in IRS Publication 502)–now, or in retirement– it comes out tax-free. Unlike a pre-tax healthcare flexible spending account, where you forfeit any unused balance at the end of the year under the use-it-or-lose-it rule, you can roll over any unused balance with an HSA, building a tax-free healthcare retirement kitty. Basically, it’s an incredible deal if you have the ability to save.

The catch is the paperwork. You have to keep records to prove that any distributions were for medical expenses. Then there’s the 20% penalty (up from 10% to help pay for Obamacare). It applies if you use the money you’ve saved in the account for non-medical expenses before age 65; once you turn 65, you can use HSA money for non-medical expenses without facing the 20% penalty, but you’ll still owe income taxes.

Here’s the rule on distribution mistakes: HSA distributions that are made by mistake can be returned to the HSA if there is clear and convincing evidence that the distribution was made “because of a mistake of fact due to reasonable cause.” In other words, if you thought something was a covered medical expense but it turned out it wasn’t. I asked Amy Gordon, an employee benefits lawyer with McDermott Will & Emery in Chicago if my take-out mistake would count under this exception. No luck. “I’m not sure I personally could make that argument with a straight face even if my lunch consisted of only ‘super foods,’” she said.

So what’s the cure? Enter the amount of ineligible distributions as “Taxable HSA Distributions” on Line 16 of Form 8889 (Health Savings Accounts) and include this amount in the total on Form 1040, line 21, entering “HSA” and the amount on the dotted line. Then calculate your additional 20% tax on line 17b and include this amount in the total on Form 1040, line 60, and write “HSA” and the amount on the dotted line.

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I suspect that is what some people do in practice (substituting a later expense to cover an ineligible expense by not submitting it) as it makes sense from a common sense standpoint. However, I think the legal answer is still that you have to report non-medical distributions as taxable distributions subject to the 20% penalty.

I can see your literal interpretation of the IRS publication. HSA administrators report to the IRS your contributions and distributions for a specific tax year. You report them to the IRS on form 8889. If there is a discrepancy and you are audited they will ask for you to show your receipts to substantiate the total amount for that year. The only way they would actually see the individual transactions is if you provided your statements. As long as you have receipts that substantiate the total amount reported for the year you will be fine. Speaking from experience.

If your HSA administrator is good they will help you out by restricting your HSA card so it only works at Merchants who are categorized with specific Merchant Category Codes (MCCs) that provide products or services that are HSA qualified. They will also restrict your HSA card so it doesn’t work at an ATM. It is very seldom medical expenses occur in $20 increments yet most Bank HSA administrators who don’t really get HSAs allow both these things.

Depending on when you catch it, what if you just went to the restaurant (or wherever you used the card by mistake) and asked them to refund and re-charge the transaction on a different card? Fundamentally it seems the same as just depositing the amount, but by providing a debit card I would think they have to accept reversals.

Thank you for posting this experience. I found this article researching an issue that just happened to me with my HSA. I had my employer put $6,000 into my family HSA for 2013–well under the $6,450 limit. We accidentally double-payed a medical bill of about $500 and the doctor refunded the amount.

In Jan 2014, my HSA provider mailed me a letter stating I had exceeded my 2013 contribution maximum and would need to take a distribution, account for it on my taxes, and pay tax on the “overage”.

They explained that it does not matter that the amount was a refund! ANY AMOUNT that comes into the HSA counts toward the contribution limit. They said this is not their rule but the IRS’s.

Am I to believe the HSA system does not account for billing mistakes in the health industry?! What if a doctor had incorrectly billed me for $2500 and I paid it? Yes, they could refund, but I’d get screwed with my HSA, take a distribution, complicate my taxes, and pay more tax than I should. I find this hard to believe.

So to answer Mr. Riquier’s comment, no, it’s not as simple as taking a refund because that can get you into trouble, too.

Our HSA is a family account and my company puts in $5000 per year. I contribute the rest via payroll deduction. I need to use $3000 of it for non-medical, but can pay it back in a couple of months with taxed money. Our HSA account is tied to our personal checking accounts and regular savings account. We are able to transfer money between any of these accounts. If I transfer out $3000 from the HSA but add it back within a couple months with taxed money via intra-bank online transfers, is this allowed? Or will this account against the max allowed contributions to that account? Thanks! -Rick

Sorry but it looks like you’re probably out of luck. I posed your question to Amy Gordon, an employee benefits with McDermott Will & Emery in Chicago. Her response: “The tax treatment of an HSA distribution will depend on the timing of the distribution and whether any unreimbursed medical expenses can be used to offset the distribution. If the HSA funds are withdrawn for nonmedical reasons, the nonmedical distributions are included in gross income and generally are subject to an additional 20% (10% for taxable years prior to 2011) tax. This would be the case even if the money way paid back to the HSA in the same plan year.” And separately, if you’re already maxing out your annual contributions, you can’t add money back in over and above that amount.

Hi I am new to US and started an HAS account only because its “Tax Free” I was not aware of the catch that its tax free for only for eligible medical expenses (even though I doubted this). So here is my question If I am taking 500$ for non medical expenses from HAS account how much I need to pay as tax penalty? Is it 20% of 500$ = 100$ If I am not contributing this 500$ from my salary, so how much will be my tax on this 500$? I am in IL.

So my HSA account is funded by pre-tax earnings. If I withdraw my funds for a non-medical expense, are they taxed AND hit with the 20% fee? My tax bracket is over 20% so I am trying to figure out if there is a loophole to be used by building my funds through the HSA for a while. Their rates are pretty solid for a savings account (.4% if the balance is over $15k.) http://www.optumbank.com/our-products-and-services/health-savings-accounts/interest-rates/